This is a blog by a 20-something in the northeast trying to figure out how she and her DH can find their way to true financial freedom.

Saturday, December 02, 2006

To Roth or Not?

A lot of people always assume that a Roth IRA is the best place for retirement investing. That is not necessarily true. A lot has to do with your current level of income. Roth investing is better if you think your current interest rate is lower than when you'll be in retirement. However if you are in a higher bracket now, but will be at a lower income during retirement, then a 401k is a better retirement shelter. But overall it doesn't matter, what matters is that you contribute to either retirement account.

Scenario 1: $1k to invest in a 401k or $800 into a Roth IRA (assume 20% bracket). For 10 years it grows @ 10% each investment. At the end you have $2593.75 in the 401k and $2075 Roth. But after 20% taxes 2593.74 becomes $2075. So there really isn't a difference.

What is a difference is where you are currently and projected to be on the tax scale. Without funding the 401k to the maximum, there is a chance we would not be eligible to fund a Roth IRA. Therefore, it is beneficial to us at our current tax rate of 25% to fund the 401k twofold. One it makes us eligible for a Roth investment, and two there is a chance we will be in a lower bracket during retirement. I project our earnings to keep rising during the next 20-30 years.

I have no crystal ball as to where our tax brackets will go so I can only assume it will be the same brackets. Whose to say that the tax rules on retirement accounts won't change either? Thus if given the option I am not sure I would change into a Roth 401k.